Forecast
- Vietnam will pursue its island reclamation projects and defense partnerships more discreetly to avoid directly challenging China.
- Despite Vietnam's efforts to connect with global markets, its reliance on imports of raw materials and incomplete industrial chains may mean that such integration could damage its export-oriented economy in the long run.
- Rising protectionism in the developed world will hamper Vietnam's attempts to overcome its structural economic flaws, rising debt, and inefficient state-owned enterprises.
Analysis
The balance of power in Southeast Asia has been quietly shifting in China's favor, and perhaps no country feels it more than Vietnam. In the span of a few months, Hanoi — once the staunchest advocate for the Trans-Pacific Partnership (TPP) — became the first participant to shelve the trade pact, well before US President-elect Donald Trump announced his intention to withdraw from it. At the same time, Vietnam softened its criticisms of China and took steps to mend ties with Beijing. Rather than positioning itself squarely in China's crosshairs, Hanoi began a more subtle pursuit of its maritime claims and alliances with stronger partners, keeping its options open and its defenses ready.
More so than most of its neighbors, Vietnam can neither fully reject nor embrace the growing power on its northern border. Some, such as the Philippines and Malaysia, have eagerly joined Chinese-led trade blocs and dispute-settling mechanisms. Others, like Japan and Singapore, have firmly backed Washington's regional agenda. Vietnam has historically opted to strike a delicate balance between the two, but as the region adjusts to a new political reality, Hanoi's strategy is becoming increasingly difficult to pull off.
A Lasting Legacy
Despite its short-lived momentum, the TPP's legacy is still alive and well in Vietnam. Shortly after Hanoi decided to suspend its approval of the US-led trade deal, the government announced a raft of new labor laws and business reforms in an apparent bid to demonstrate its continued commitment to the TPP's high regulatory standards. It also took steps to integrate its economy more closely with those of other TPP signatories and regional trade blocs, including the Chinese-backed Regional Comprehensive Economic Partnership and Free Trade Area of the Asia-Pacific.
In fact, Vietnam has embarked on one of the most active quests for free trade in the Pacific Rim. From Hanoi's perspective, deals like the TPP are perfect for attracting foreign investment and buyers for its exports, both of which are crucial to ensuring its success amid heightened regional competition and its gradual reform of the Vietnamese economy. (Currently, inefficient state-run enterprises are responsible for much of the country's economic output.) Though Vietnam was the least developed member of the TPP — and, in many ways, the one that would have proved most vulnerable to its strict requirements — it was also the state that stood the most to gain from it. Despite the deal's impending failure, Hanoi has pursued a fairly liberal trade agenda that has left it with a cushion of other free trade agreements to fall back on, including with the Eurasian Economic Union and European Union. (The former already has taken effect, while the latter is scheduled to be implemented in early 2018.)
But as was true with the TPP, Vietnam's motives for seeking out these trade and investment agreements are not solely economic. Hanoi's deal with the Eurasian Economic Union, for instance, offers only limited access to the bloc's market but lays the groundwork for a stronger military and energy partnership with Russia, its former ally. By comparison, EU members and TPP states receive nearly 60 percent of Vietnam's total exports and include some of its biggest investors, such as Japan, Singapore, and the United States. Nevertheless, the two blocs set lofty standards that would require Hanoi to undertake extensive regulatory overhauls and politically sensitive labor union reforms that could directly threaten the operations of its bloated state-owned enterprises. That the Vietnamese government is willing to do so in spite of the risks to its own position in power is a testament to its desire to seek out trade partners other than China and, by extension, limit Beijing's influence over Vietnam.
But putting its plan into practice has been no easy feat. Vietnam's industry is still heavily reliant on Chinese yarn, fabric, and electronics, and its recent territorial feuds with Beijing in the South China Sea have raised doubts about whether Hanoi can continue to count on those supplies. Vietnamese imports of Chinese goods increased most rapidly between 2010 and 2015 when tensions between the two countries reached their peak. This, combined with a growing reliance on imports that has reduced the profitability of Vietnam's exports, suggests that Hanoi may have a tough time improving its economic fortunes. The TPP or a free trade agreement with the European Union would expand Vietnam's access to other markets and foreign partners, eventually reducing its dependence on Chinese products. But in the short term, these deals will offer little relief. From Hanoi's perspective, signing the TPP when it essentially has been tabled would needlessly irritate Beijing, which considers the TPP to be part of a US-led strategy to contain China's rise.
Lingering Barriers to Free Trade
Choosing between the US and Chinese-led initiatives in trade and security has not been an option for Vietnam since the Cold War ended. Instead, the country has harnessed its advantageous location and regional clout to make steady gains of its own on both fronts, making room to manage its relationships with meddlesome foreign powers while emerging as one of the biggest manufacturing success stories in the Asia-Pacific region. Yet as much as Hanoi would like to link its economy to the rest of the global market, rising protectionism in the developed world and lingering vulnerabilities in its political economy at home will stand in the way of its ambitions.
Over the past two years, a spurt of economic growth driven by robust exports and investment allowed Vietnam to pull ahead of regional competitors like Thailand, Indonesia, and Malaysia, whose growth slowed during the same period. But with an export-oriented economy that runs on foreign investment, the country's deepening integration with the rest of the world has made it vulnerable to volatility in global markets while squeezing its domestic manufacturers. After years of generous foreign investment, investor pledges have tapered off in recent months, a sign of the challenges to come for Vietnamese exports in the wake of the TPP's demise. Meanwhile, growing protectionism in the United States and the European Union — Vietnam's largest export markets — bode ill for its economic prospects, as do the trade disputes brewing between Washington and Beijing. The timing of those developments could not be worse for Hanoi, which is in the midst of a painful effort to restructure its economy that could put pressure on some of Vietnam's most important industries, including agriculture, steel, and electronic components.
The country's manufacturing supply chains, moreover, are far from complete. Vietnam must import many of the raw materials it uses to generate its exports. This, coupled with the country's lack of supporting and processing industries, has cut into producers' profit margins and limited their ability to add value. Without a long-term strategy to develop these industries and boost its productivity, Vietnam is vulnerable to external disruptions to its supplies. Hanoi has been forced to make do on a tight income and with meager export revenue. It has also seen its budget deficit grow to nearly 6.5 percent of GDP, aided in part by ballooning expenditures, plummeting oil prices and surging debt-service obligations. All of these issues have been aggravated by Vietnam's persistent macroeconomic problems, including its fragile banking system, an excessive number of non-performing loans, underdeveloped regulations and lagging public enterprise reforms, as well as continued volatility in global commodity prices and financial markets.
A Deeply Rooted Rivalry
The appearance of these new economic problems against a backdrop of mounting political uncertainty — both from the United States' unclear intentions for the Asia-Pacific region and in recent signs that Vietnam's neighbors may be starting to break their collective front against China — may have been the impetus behind the change in Vietnam's diplomatic tactics. But there are limits to how much less contentious its relationship with China can get — and how long Beijing will ignore Hanoi's muted assertiveness.
Vietnam's resistance to Chinese invasion has deep historical roots, and a vein of nationalism still runs strong among its people. Each of these factors will continue to prevent Hanoi from following in Malaysia's footsteps by cozying up to Beijing. Moreover, unlike the Philippines, Vietnam has no US security guarantee to protect it from Chinese aggression, despite its fairly friendly relationship with Washington. Consequently, Hanoi has worked to build up its own defenses and island claims in the South China Sea, all while continuing its drive for closer security cooperation in the region.
To be sure, among all regional challengers to China's maritime expansion, Vietnam is still the most militarily capable. But multilateral organizations like the Association for Southeast Asian Nations will not be much help in deterring Chinese expansionism in the disputed waters. And as other major claimants in the South China Sea begin to pivot to varying degrees toward China, Vietnam will find itself alone in its stand against Beijing. Having given no indication that it intends to lay its maritime disputes with China to rest, Vietnam will continue to discreetly bolster its forces and alliances, even at the risk of drawing Beijing's ire.
"Against China, Vietnam Stands Alone" is republished with permission of Stratfor.
